Indian Investors’ Dilemma – A study of financial market paradigm
conflict through behavioral finance approach.
- Dr.Mahabaleswara Bhatta HS
ABSTRACT
The decade (1998-2008) saw a great momentum in the investment scenario of Indian financial
market. There was an unprecedented spurt in the stock trading volume both in the regular stock
exchanges and over the counter exchange of India. People from various walks of life ,through
information technology advancement empowered themselves to be well informed , stormed in to
the investment market. What was hither to the domain of upper middle and above ,became a
common playground for even the middle and lower middle groups. They jumped into the market
with little savings that they have, in the hope of making big bucks without recognizing the
underlying and hidden risk element in such investments. Overlooking the need to understand the
fundamentals of the market themselves, they just relied on others’ opinions and suggestions. This
led to a remarkable shift from rationality to irrationality in the investment behavior.
The current study emphasizes the paradigm in the financial market scenario and investigates
through behavioral finance approach whether , in the milieu, the Indian investors are really
trapped and then ,attempts to throw some tips to get out of the trap.
Key words: Financial Market, Milieu, Investment trap, Paradigm, Rationality , Irrationality ,
Behavioral finance.
Paper to be Presented at Osmania University Conference , 5,6,7, March 2010.
FULL PAPER
Title: Indian Investors’ Dilemma – A study of financial market paradigm conflict
through behavioral finance approach.
- Dr.Mahabaleswara Bhatta HS
Author : Dr.Mahabaleswara Bhatta.H.S
Global Institute of Management Sciences,
#6,3rd Cross,D Road,Ideal Homes Township,
Rajarajeswari Nagar ,
Bengaluru -560098.
Email : maabi_bhat@yahoo.co.in
Introduction:- There is a Phenomenal growth in the investment sector both in terms of volume
and number of investors. There is a spurt of various investment products with numerous
options to lure the investors to invest. The number of stock exchanges has increased to 22.
Equity shares as an investment option has come a long way from the mere higher dividend
expectations to the greater capital appreciation. Price discovery through Book Building process
has given tremendous boost to the Initial public offers (IPO) and further public offers (FPO). The
quadruple structure of the investment market -Investor, Issuer, intermediaries and Regulator,
has strengthened. The pattern and dimension of investment has changed over time. The
investment Scenario of Indian Financial market wears a new look, with a overwhelming
response not only from the Indian investors but also from foreign institutional investors. The
quality of ever changing regulations, the payment guarantee by the depositories, Productive
involvement of the Government, vibrant intermediaries and up to date and technologically
advanced exchanges, all have instilled a sense of confidence among the investors. The powerful
and cost effective communication net work has made the investors, even from a small village to
take part in the investment process.
This has broad based the investors and hence created a healthy environment for a
stable investment market.
Theoretical framework: The Efficient market hypothesis implies that the market establishes the
right price for the equities. It assumes that investors are rational ,orderly and tidy. Based on this
assumption, Investors make Fundamental analysis and Technical analysis before finally taking
investment decision to buy or sell the securities. These statistical tools help to make logical
conclusions. However, behavioral paradigm argues that there is often a divergence between
the fundamental value and market price. Markets are not orderly or simple. Prices vary over a
very wide range ,dependent on bullish enthusiasm, concentrated speculative interest and other
influences.
According to C.Rangarajan, former Governor of RBI, “ Share price in India tends to be
considerably influenced by short term technical consideration and speculation. The
fundamentals affect the share price after a considerable time lag. This disparity of perception
leads to volatility and over heating of the stock market”.
Where as Dr.Manmohan Singh, Hon’ble Prime Minister of India, says, “Stock market’s behavior
in India has often had no relation with the fundamental strength of the economy. It is often in
response to the sentiments that are shared in the market”.
Irwin Friend expresses that “There have been numerous occasions when bodies of investors
have been emotionally affected by fads and fashions in Wall Street”
According to Robert Shiller, the excess volatility in stock prices is not due to changing
expectations about future dividends, but due to the propensity of investors to trade on fads
and fashions, thus inducing speculative bubbles.
Thus, it is evident that market at times display high irrationality causing significant discrepancy
between intrinsic values and market prices. There are sufficient evidences to this type of
unwieldy behavior of the market. In India, the sensex rose over 20,000 points and fell back to
below 8,000 points in a short span of about 3-4 months in 2008.
Research Questions:- The premise of this study has been structured around the following
research questions:
1. Has the paradigm of investment base really brought in the
required stability of prices in investment market?
2. Whether the investors really base their decision on the assumption
of efficient market hypothesis ?
3. Whether the investors have got effective orientation about
investment trading?
4. Whether the behavioral finance tenets can throw light on
rationality in the investment decision making process?
Statement of the problem:- In the backdrop of the above research questions the problem of
the study in stated as below:Not all investors in India are well educated about the investment intricacies. Not all
investors are knowledgeable about the happenings in the investment scenario. The up spring of
various investment products & schemes have lured the investors to jump in to trading.
Investment has become a habit without the support of essential information and knowledge. In
spite of the best scientific approaches, the price movement has become a chimera. The nonpredictability of the price fluctuation and the desire to make huge bucks have paved the way
for irrational judgments.
Over the study period (1998-2008), the market has seen violent fluctuations. The prices
increased dramatically tempting the investors to buy the shares in the expectation of further
hike. However, they are now struck. Due to long recession, shares bought at higher prices
have remained stagnant at low price level for a lengthier time than expected. They are in a
precarious position, whether to stay put or come out of the situation. This study Investigates
from behavioral finance angle, as to whether the investors were biased while taking decision
and as a consequence are they trapped in the investment cobweb.
Methodology:- Secondary data is collected in respect of the following :1. Data regarding the investment on equity shares over 10 year
period 1998-2008.
2. Data regarding their price movements over the study period.
3. The intrinsic values of the designated shares and their
Comparison with market values
Scope of the study: The study period is 1998-2008. The study pertains to 10 Indian Companies
listed in National Stock Exchange(NSE).
Sample:- 10 companies belonging to different sectors are selected on a selective random basis.
Data relating to these10 companies are collected and analyzed. The percentages are calculated
in order to establish the relationship between the variables.
Analysis:Based on the research design , the data are presented in the form of tables and analyzed by
calculating the percentages of increase or decrease.
Table 1
Resource mobilization from public equity shares
Issues
2006-07
Number
Amount
Rs. mn
2,85,040
50,040
12,930
37,110
3,35,080
2007-08
Number
Amount
Rs. Mn
4,25,950
4,44,340
1,19,160
3,25,180
8,70,290
IPOs
77
85
Issues by listed Cos:
47
39
a.Public issues
8
7
b.Right issues
39
32
Total
124
123
Source:- SEBI
From Table 1, it can be observed that ,The issue of IPOs has increased by Rs1,40,910 Mn i.e
49.44% from 2,85,040 Mn in 2006-07to Rs4,25,950Mn in2007-08.Where as the Public issues
from listed companies saw a significant rise of 822% from 12,930 Mn in 06-07 to 1,19,160 Mn in
2007-08. The overall Total resource mobilization from public issues increased by 159.73% to
Rs.8,70,290 Mn in 07.08 from Rs.3,35,080 Mn in 2006-07.
The above figures show that there is enormous participation of the public in the equity
investment market.
Table 2
Sl.No
Performance of IPOs issued on NSE during 07-08
Comp Name
Sector Issue price Price at the end Price appreciation
1
2
3
4
5
6
7
8
9
10
Orbit Corpn Ltd
ICRA Ltd
Advanta India Ltd
Hilton Metal Forging
MIC Electronics Ltd
Celestial Labs Ltd
Everonn System Ltd
Central Bank of India
Puravankara Projects
Reliance Power Ltd
Infra
Finance
FMCG
Mfg
Telcom
Pharma
Telcom
Bank
Infra
Infra
110
330
640
70
150
60
140
102
400
750
of Mar
(depreciation) %
527.10
379.18
664.05
101.25
1063.65
66.20
27.70
(60.45)
715.30
376.87
3730
(3783)
584.35
317.39
86.90
(14.80)
241.05
(39.74)
318.00
(29.33)
Source:NSE
From Table 2 , it can be observed that ,there is a significant difference between the issue prices
and the prices at the end of March 2008 of the selected shares.
While 50% of the selected shares have shown the appreciation, the remaining 50% have shown
the decline. Finance, FMCG and Telcom shares have shown a significant increase ,where as
Mfg, Pharma, Bank and infra (except Orbit Corporation) have shown a significant decrease in
the share prices.
This data indicates the volatility in the share prices in different sectors.
Table 3
Resources raised by Corporate Sector
Year
97-98
98-99
99-00
00-01
01-02
02-03
03-04
04-05
05-06
06-07
07-08
Public Equity Issues
(Rs Mn)
11,320
5,040
29,750
24,790
10,820
10,390
1,78,210
2,14,320
2,36,760
2,49,930
5,22,190
Debt Issues
3,29,120
4,61,550
5,93,990
5,65,725
5,15,610
5,31,666
5,27,519
5,42,788
8,18,466
9,25,552
11,62,661
Total
3,40,450
4,66,580
6,23,740
5,90,520
5,26,430
5,41,556
7,05,729
8,07,108
10,55,226
11,73.482
16,84,851
Source: Prime data base
During 07-08, total resource raised by corporate sector Increased by 43.53% to 16,84,851 Mn as
compared to 11,73,782 Mn and in that equity route was 30.99% where as debt 69.0%.
The significant factor is that the Equity issue has increased from Rs11,230 Mn in 1997-98 to Rs
5,22,190 Mn in 2007-08. That is a hopping increase by 4550%.
Since April 2007 SEBE has made it mandatory for all IPOs to be graded by SEBI registered rating
agencies. IPO rating in designed to provide Investors an independent, reliable & consistent
assessment of the fundamentals of new IPO offering.
However, rating agencies neither comment on the pricing nor do forensic audit. It is not more
than what knowledgeable investor can himself gather from the offer document. Thus, investor
not so knowledgeable, is subject to bias while taking a decision on investment.
Table 4
Capital market turn over on stock exchange in India
Stock exchanges
NSE
BSE
Others
Total
2006-07
Rs Mn
19,452,865
9,561,850
15862
29,030,577
2007-08
Rs Mn
35,510,380
15,788,570
4850
51,303,700
% Increase
82.55%
65.12%
Source:-NSE
Table 4 shows the capital market turn over in 19 stock exchanges in India over a period of 2
years from 2006-07 to 2007-08. It can be observed that in NSE the increase is by 82.55% and in
BSE it is 65.12%. The figures relating to other 17 stock exchanges put together is insignificant.
The decline in other stock exchanges is due to technological advancement and hence the two
major stock exchanges are catering to the tune of over 99 %.
This significant increase in capital turn over indicates the increased participation of the
investors over a year.
TABLE 5
Price Movements of IPOs issued on NSE
Sl.No
Comp Name
Sector
1
2
3
4
5
6
7
8
Orbit Corpn Ltd
ICRA Ltd
Advanta India
Hilton Metal
MIC electronic
Celestial Labs
Everon System
Central Bank of
India
Puravankara
Project
Reliance Power
Infra
Finance
FMCG
Mfg
Telcom
Pharma
Telcom
Bank
9
10
Price on Mar Nov 15,09
% Increase
31,08
(or decrease)
527.10
289.05
(45.16)
664.05
770.95
1.16
1063.65
617.00
(41.99)
27.70
17.95
(35.20)
715.30
41.30
(94.23)
37.30
25.90
(30.56)
584.35
426.25
(27.06)
86.90
152.30
175.25
Infra
241.05
101.55
(57.87)
Infra
318.00
143.65
(54.83)
Source:- NSE, Sharekhan.Com, (15.11.09)
Table 5 shows the price change of IPOs issued in NSE from March 31,2008 to November
15,2009. The change ,increase or decrease , is expressed in percentages.
It can be observed that except ICRA and Central Bank , all the other companies have shown a
significant decrease in the prices. The prices are quoted very low in the stock exchanges.
This indicates that , those investors who purchased the shares of these companies on March
31,2008 and wishing to sell the shares on Nov 15, 2009 will be incurring huge losses. Those
who purchased the shares hoping an increase in shares based on the issue price of these shares
are at positional loss. They are neither in a position to dispose nor in a position to retain. A
situation of being trapped.
TABLE 6
Comparison of intrinsic value and Market value
Reference Return = 10% PA
Sl.No
Comp Name
EPS
Intrinsic Value Market Value
1
Orbit Corpn Ltd
8.43
84.30
289.05
2
ICRA Ltd
36.00
360.00
770.95
3
Advanta India
5.09
50.90
617
4
Hilton Metal
2.00
20.00
17.95
5
MIC electronic
5.50
55.00
41.50
6
Celestial Labs
6.51
65.10
25.90
7
Everonn System
18.28
182.80
426.25
8
Central Bank of
14.13
141.30
152.30
India
9
Puravankara
4.81
48.10
101.50
Project
10
Reliance Power
1.04
10.40
143.65
Intrinsic value = EPS/Reference Return
Ex: Orbit Corporation Ltd; 8.43/0.1 = 84.30
% Hype
342.88
214.16
1212.18
(8.96)
(7.51)
(3.98)
233.18
107.79
211.12
1381.25
Table 6 shows the comparison of Intrinsic value of the selected shares with that of their market
values on a particular date. The intrinsic value is calculated on the basis of a reference return of
10% Per Year.
It can be observed from the table % Hype column that, except Hilton, MIC and Celestial, all
other shares are sowing a significant difference between the intrinsic value and market value,
i.e intrinsic value being far less than the market value.
These figures indicate that the reference shares are over valued to a great extent. It means that
the investors are paying much more than its real worth. Such a situation tends to create Bubble
in the market. A bubble is only an illusion, not real and hence likely to be burst at any time.
Behavioral Finance Approach: Retail investors are an important segment in the stock
market and their prudent presence is very essential for a healthy growth of stock market . The
long belief of the Efficient Market Hypothesis is gradually being eroded. Empirical studies have
time and again proved that the irrational behaviors have caused stock market bubbles and
crashes. The knowledge so developed through the studies would provide a framework of
behavioral principles within which the investors can critically inspect their investing decisions
and if need be ,take corrective actions to hopefully make their future financial decisions a bit
more rational and a lot more lucrative as well.
Theoretical and empirical evidence suggested that Capital Asset Pricing Model , Efficient Market
Hypothesis and other rational financial theories did a respectable job of predicting and
explaining certain events (Robert J.Shiller ,2003). However, the real world is altogether different
and in which, market participants often behave very unpredictably. The fact is, investors frequently
behave irrationally. The January Effect (Michael and William,1976),The Winner’s Curse (Robert
Thaler,1988) and The Equity Premium Puzzle are the stock market anomalies that remained unexplained
by the traditional theories. These anomalies prompted academics to look to cognitive psychology to
account for the irrational and illogical behaviors(Albert Phung,2002). Investors trade for both cognitive
and emotional reasons. They trade because they think they have information when they have nothing
but noise, and they trade because trading can bring the joy of pride. Trading brings pride when decisions
turn out well, but it brings regret when decisions do not turn out well.
Now, let us look in to some of the most prominent behavioral biases that cause irrational decisions:
Prospect theory explains the occurrence of the disposition effect, which is the tendency for investors to
hold on to losing stocks for too long and sell winning stocks too soon. The most logical course of action
would be to hold on to winning stocks in order to further gains and to sell losing stocks in order to
prevent escalating losses.
Anchoring Bias: Kahneman and Tversky(1974) have provided an academic evidence of the presence of
strong anchoring effect even in random cases. According to them, investors have the tendency to attach
or "anchor" their thoughts around a reference point despite the fact that it may not have any logical
relevance to the decision at hand.
Mental Accounting :Some Investors have the tendency of separating the found money and the
earned money from the standpoint of the purpose for which it is utilized. Found money is
recklessly spent where as extra caution is used to spend earned money , though there is no
logical reason to distinguish.
Confirmation Bias :The investors would be more likely to look for information that supports his
or her original idea about an investment rather than seek out information that contradicts it.
As a result, this bias can often result in faulty decision making.
Hindsight Bias:The belief that they can easily predict the future based on the past events may result in
incorrect oversimplifications and disastrous investment decision.
Gambler’s Fallacy :Often, Investors erroneously believe that the onset of a certain random event
is less likely to happen following an event or a series of events. Investors can easily fall prey to
this gambler's fallacy.
Herd behavior:Investors have the tendency to mimic the actions (rational or irrational) of a larger group.
Researchers have theorized that investors follow the crowd and conventional wisdom to avoid the
possibility of feeling regret in the event that their decisions prove to be incorrect.
The “Crowd effects” have resulted in nasty turbulences in the stock market(Showry&Tabassum,2007)
Over Confidence :Investors are consistently overconfident in their ability to outperform the market,
however, most fail to do so (James Montier,2006).
At the height of optimism ,greed moves the stocks beyond their intrinsic value ,creating an overpriced
market. At other times ,fear moves prices below intrinsic value, creating an under valued market.
In recent years it has been experienced that the market frequently mispriced the stocks. This is most
often caused by human emotions of fear and greed (Meir Statman,1988).
Following are some of the tips to avoid being trapped by the investors’ biases:
(1)It is possible to minimize the disposition effect by using a concept called “Hedonic Framing” to change
investors’ mental approach. If investors try these methods of framing, their thoughts should make their
experience more positive.
(2) Anchoring can be avoided by a rigorous critical thinking about the figures that are used for
the evaluation of a stock’s potential.
(3) Mental accounting bias can be avoided if the investors think that the money is fungible.
(4) A solution to overcoming confirmation bias would be finding someone to act as a "dissenting voice
of reason". That way investors will be confronted with a contrary viewpoint to examine.
(5) Just because everyone is jumping on a certain investment "bandwagon" doesn't necessarily
mean the strategy is correct. Therefore, it is necessary for an investor to always do proper
homework before following any trend.
(6)Availability bias can be avoided if the investors retain a sense of perspective.
Conclusion
There is a paradigm shift of attention from the Efficient Market Hypothesis to Behavioral Finance.
Though there is no concrete solution to the unpredictable human behavior , several studies by the
behaviorists have time and again thrown light on the consequences of wrong judgments. These studies
have helped to provide a broader framework within which the investors can critically inspect their
investing decisions. A set of behavioral principles would certainly guide the investors to be in the race
continually and yet make reasonable gains in trading.
In India, Securities Exchange Board(SEBI) has realized the importance of the presence of
individual investors for a healthy growth of stock market. To this end ,there is a need to
educate and counsel the investors from time to time about the wisdom required in the stock
trading and also about the unethical and tactical practices of brokers ,shady dealings of the
companies and the insider trading.
The NSE conducts Awareness & Education seminars on a regular basis across various centers.
Informative brochures & booklets are distributed. 415 investor awareness programs were held
during 2008.It has also created Investor Protection funds.
However, Behavioral finance offers no investment miracles, but it can help investors train themselves
how to be watchful of their out behavior and, in turn, avoid mistakes that will be disastrous.
References:
Albert Phung, 2002, “Taking a chance on Behavioral Finance”,www.Investopedia.com
Daniel Kahneman and Amos Tversky, 1979, “Prospect Theory:An analysis of
decision making under risk”,Econometrica.
Meir Statman, 1988, “Investor psychology and market inefficiencies” Equity
Markets and valuation methods, The institute of Chartered financial Analysts.
Prasanna Chandra, 2008,”Investment Analysis and Portfolio Management”,3rd Ed,Tata McGrawHill.
Robert J.Shiller ,2003, “From efficient market theory to Behavioral Finance”,Yale
University-Cowles,Discussion Paper 1385.
www.nse.com
www.bse.com
www.investorhome.com
www.proquest.com
http://digitalcommons.pace.edu/honorscollege theses/44